The price-to-peak earnings multiple fell slightly to 9.8x this week. The S&P 500 dropped a seemingly modest 2.25% last week, which seems tame in comparison to recent market action. We are starting to see a market that appears to have discounted in much of the bad news, as we saw an awful unemployment report and a Fed Beige Book report showing substantial weakness in retail sales, slowing manufacturing, compressed tourism spending, continued weak home sales, a tough labor market and price deflation. The interesting part about this was not that these developments came as any great surprise but that the market did not react quite negatively to the news. In a bear market, when investors turn bullish in the face of gloomy news, it is a strong signal that the capitulation phase has passed. We believe that the stock market has largely priced in a long and deep recession, thus the bleak actual data released over the past few weeks is already “baked in to the numbers”. While there is no way to know definitively that the market has reached bottom, its valuation appears to be stabilizing even in the face of dreary news. This is a positive sign looking forward.
The percentage of NYSE stocks selling above their 30-week moving average remained extremely low at just 5% this week. Investor sentiment rarely reaches the depressed levels that we have seen sustained for the last nine weeks. Last week, the National Bureau of Economic Research (NBER) made the recession official, stating that the domestic economy has been in recession since December 2007. This makes official what everyone has known for some time now. However, we believe that this recession has been exacerbated by the overwhelmingly negative reporting on the economy by those in the media during the political campaign. Some have used the hyperbole of calling this the worst downturn since the Great Depression which, while not entirely inaccurate, misrepresents what we are actually dealing with. John Hussman Ph.D. describes the scenario this way:
“While we do expect fourth-quarter GDP to come in at a loss of -4% to -6%, it is important to recognize that this is a quarterly change at an annual rate. The overall contraction in U.S. output will be somewhere about 1-1.5% in the fourth quarter. In the Great Depression, actual GDP dropped by 30%. Ben Bernanke was correct in remarks he made last week that there is “an order of magnitude” (10 fold) difference between the current downturn and the Great Depression. For the record, the worst overall draw-downs in GDP since the Great Depression – not just bad quarterly growth rates – were in 1954 (-2.65%), 1958 (-3.75%), 1975 (-3.10%), and 1982 (-2.87%).
This is not to minimize the prospects for a further economic downturn, but to say that this is “the worst economy since the Great Depression” is like blowing up a crate of dynamite on the Nevada Proving Grounds and saying it is the worst explosion since the detonation of the atomic bomb there. Even if the statement is accurate, the comparison is absurd.”
We are maintaining our bullish stance towards long-term equity exposure in our asset allocation model this week. While it certainly does make us a bit queasy to stick our neck out at times such as these, circumstances like this combining favorable valuations and extremely negative sentiment are simply too rare to pass up. These are the exact opportunities that long-term value investors should drool over. Risk is an essential compliment of above average returns, but risks should not be taken with out a reason. Furthermore the juxtaposition of both favorable valuation and negative sentiment exists at a time when governments around the globe are actively pursuing stimulative monetary and fiscal policies. We have been vocal opponents of government intervention, but we are where we are, so we hope that the policies have the desired effect and at least will not do any harm in the short-term. We are not making the case that we will be back to DJIA 12,000 any time soon, but we would not be surprised if stocks did begin to ascend, possibly rapidly.